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Getting off the hook

Parishil Patel QC and Katherine Barnes provide a guide to securing release from contractual obligations and varying public contracts in light of COVID-19. [1]

Given the current challenging economic circumstances arising from the COVID-19 pandemic, which the authors fear may worsen over the coming months as employers are weaned off the Government’s furlough scheme, contracting authorities and their contractors may want to be released from obligations under existing contracts (and/or to protect their position having already defaulted on their obligations). Similarly, contracting authorities may want to vary existing contracts going forward. However, for obvious reasons, notably the time and cost involved, the appetite for undertaking a new procurement exercise is likely to be limited. This article therefore provides a guide to the available options for achieving these objectives.

Securing release from existing contractual obligations: force majeure clauses

In broad terms, a force majeure clause excuses a contractual party from the non-performance of a contractual obligation where the non-performance arises from an extraordinary event or circumstance beyond their control. Whether a force majeure clause covers non-performance or late performance due to the COVID-19 pandemic will depend on the construction of the particular clause being relied on. In theory, however, if the pandemic falls within the relevant clause, then the defaulting party may be released from their obligations.

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In practice, however, it is not quite that simple. The first reason for this is the principle that the extraordinary event must be the sole cause of the non-performance [2]. The second and related reason is that force majeure clauses are typically accompanied by an obligation to exercise reasonable endeavours to mitigate the effects of the force majeure clause (in other words, reasonable endeavours must be exercised to avoid non-performance). Even where there is no express reasonable endeavours requirement, the defaulting party will struggle to satisfy the “sole cause” test if there were alternative means of fulfilling their contractual obligations which they chose not to pursue.

It seems to the authors that these well-established contractual principles may pose real difficulties for those seeking to rely on force majeure clauses in the COVID-19 context due to, amongst other matters, the nature of the legal framework introduced by the Government for managing the pandemic. That is because the various sets of Regulations [3] dealing with the pandemic often include an exemption to the general requirements imposed on the public where necessary to “fulfil a legal obligation”. For example:

(a) The Health Protection (Coronavirus, Restrictions) (England) Regulations 2020 [4] disapplied the requirement to stay at home and not to participate in gatherings or more than two people where necessary “to fulfil a legal obligation” (Regulation 6(2)(h) and Regulation 7(d)(iv));

(b) The Health Protection (Coronavirus, Restrictions) (No. 2) (England) Regulations 2020 [5] disapply the prohibition on participating in gatherings of over 30 people where the participant is “fulfilling a legal obligation” (Regulation 5(3)(d)). Notably, and unsurprisingly, there is no such exemption in the business closure requirements;

(c) The Health Protection (Coronavirus, Restrictions) (England) (No. 3) Regulations 2020 [6] excuse a person from a local authority’s prohibition/restriction on entering a specified public outdoor place where the person is required to enter the space in question “to fulfil a legal obligation” (Regulation 7(4)(d)(iii));

(d) The Health Protection (Coronavirus, Restrictions) (North of England) Regulations 2020 [7] disapply the prohibition on gatherings of two or more people in private dwellings in certain parts of the North of England where the relevant person “is fulfilling a legal obligation” (Regulation 5(2)(d));

(e) The Health Protection (Coronavirus, International Travel) (England) Regulations 2020 [8] exempt a person from the need to remain at their chosen quarantine location on return from one of the relevant countries where they are required to leave that location “to fulfil a legal obligation” (Regulation 4(9)(c)).

As such, it would seem that in many instances the need to fulfil legal obligations, which on the face of it include the honouring of existing contractual responsibilities, operates as an exemption to the rules imposed on the public, and therefore contractors, for the management of the pandemic. This in turn risks seriously undermining the argument of a defaulting contractual party that they have complied with their reasonable endeavours obligation. That is because, in many instances, it will not be possible to assert that the law compelled non-performance. Indeed, it could be argued that in such circumstances the defaulting party simply elected not to fulfil their obligations with the result that the protection offered by the force majeure clause is not triggered.

It follows that careful consideration of the contract and all the circumstances is required before a contractor seeks to rely on a force majeure clause to excuse non-performance due to COVID-19. In some instances a force majeure clause may well provide a “get out of jail free card”, but it cannot be assumed that is the case.

Varying public contracts under the Public Contract Regulations 2015

Of course, if a contract cannot be suspended or its obligations terminated thanks to a force majeure clause, it may also be possible to renegotiate the terms of the contract going forward.

This raises particular issues for public sector contracts given the applicable procurement rules. Indeed, despite a recent flurry of procurement guidance from the Government in light of COVID-19 [9], the Public Contract Regulations 2015 (“the PCR”) remain fully in force. This means that contracting authorities will need to consider Regulation 72 (“Reg 72”) of the PCR which sets out the limited circumstances in which a contract may be varied without requiring a new procurement exercise [10]. Reg 72 provides for six exceptions in this regard:

(1) Express amendment clauses (Reg 72(1)(a));

(2) Necessary additional works, services and supplies by the original contractor (Reg 72(1)(b));

(3) Unforeseen circumstances (Reg 72(1)(c));

(4) New contractor (Reg 72(1)(d));

(5) Non-substantial changes (Reg 72(1)(e));

(6) Minor variations (Reg 72(1)(5)).

Exception (1): Express amendment clauses

Exception (1) applies where the initial procurement documents provide for amendments to the contract (regardless of their value) in clear, precise and unequivocal review clauses, as long as such clauses:

(i) state the scope and nature of possible modifications as well as the conditions under which they may be used; and

(ii) do not provide for modifications that would alter the overall nature of the contract.

This exception was considered in the Edenred litigation, with the Supreme Court (Edenred (UK Group) Ltd v HM Treasury [2015] UKSC 45) commenting that “the most significant restriction in this regulation is the degree of specification that it requires in the review clause” (Lord Hodge at [42]). The court went on to uphold the decision of the Court of Appeal that the exception was made out in circumstances where the initial contract envisaged the extension of the services in question, and also confined the extension to opportunities within the scope of the original OJEU notice, as well as restricting any increase in the contractor’s profit margins (at [43]). It follows that careful scrutiny of the original contract will be required to determine whether authorities may rely on this exception.

Exception (2): Necessary additional works, services and supplies by the original contractor

Variations are allowed for additional works, services or supplies by the original contractor that have become necessary and were not included in the initial procurement, where a change of contractor:

(i) cannot be made or economic or technical reasons; and

(ii) would cause significant inconvenience or substantial duplication of costs for the contracting authority;

provided that any increase in price does not exceed 50% of the value of the original contract.

On the face of it, there is no obvious link between this exception and COVID-19. Rather, Recital 108 to the Directive [11] indicates that this exception is intended to apply: “in particular where the additional deliveries are intended either as a partial replacements [sic] or as the extension of existing services, supplies or installations where a change of supplier would oblige the contracting authority to acquire material, works or services having different technical characteristics which would result in incompatibility or disproportionate technical difficulties in operation and maintenance.” That is not to say, however, that certain contracts which require amending due to the pandemic may not fall within this category. What is required is a careful examination of the circumstances of a particular contract, including the identification of compelling reasons why economic and/or technical reasons prevent a change of contractor.

Exception (3): Unforeseen circumstances

A contract may be varied where all three of the below conditions are met:

(i) the need for modification has been brought about by circumstances which a diligent contracting authority could not have foreseen;

(ii) the modification does not alter the overall nature of the contract;

(iii) any increase in price does not exceed 50% of the value of the original contract or framework agreement.

In this regard, recital 109 to the Directive provides: “Contracting authorities can be faced with external circumstances that they could not foresee when they awarded the contract, in particular when the performance of the contract covers a long period. In this case, a certain degree of flexibility is needed to adapt the contract to those circumstances without a new procurement procedure. The notion of unforeseeable circumstances refers to circumstances that could not have been predicted despite reasonably diligent preparation of the initial award by the contracting authority, taking into account its available means, the nature and characteristics of the specific project, good practice in the field in question and the need to ensure an appropriate relationship between the resources spent in preparing the award and its foreseeable value.”

Plainly, this exception is likely to prove of particular assistance in the COVID-19 pandemic given that this constitutes a quintessential unforeseen circumstance. Indeed, the Cabinet’s Office’s PPN 01/20 [12] makes express reference to this exception, and advises:

“Contracting authorities should keep a written justification that satisfies these conditions, including limiting any extension or other modification to what is absolutely necessary to address the unforeseeable circumstance. This justification should demonstrate that your decision to extend or modify the particular contract(s) was related to the COVID-19 outbreak with reference to specific facts, eg your staff are diverted by procuring urgent requirements to deal with COVID-19 consequences, or your staff are off sick so they cannot complete a new procurement exercise.”

Unfortunately there is no case law which addresses directly the issue of when the “nature” of a contract changes in this context, but some of the guidance from the authorities outlined below (on when a variation is “substantial”) may provide some assistance in this regard.

Exception (4): New contractor

Substitution of an initial contractor amounts to an exception where the replacement arises as a consequence of:

(i) an unequivocal review clause or option (i.e. the original contract made provision for the replacement); or

(ii) corporate restructuring (including takeover, merger, acquisition or insolvency).

While a narrow exception, it is of obvious relevance to the economic fallout from COVID-19 given that significant numbers of contractors risk insolvency due to the reduction in demand for various goods and services, as well as the financial pressures resulting from new regulatory requirements.

Exception (5): Non-substantial changes

Variations, irrespective of their value, will fall within this exception as long as they are “not substantial”.

A variation will be “substantial” (with the result that it falls outside the exception) if it meets one of more of the following conditions (as per Reg 72(8)):

(i) The variation renders the contract materially different in character from the one initially concluded;

(ii) The variation introduces conditions which, had they been part of the initial procurement procedure, would have: allowed for the admission of other candidates than those initially selected; allowed for the acceptance of a tender other than that originally accepted; or, attracted additional participants in the procurement procedure;

(iii) The variation changes the economic balance of the contract in favour of the contractor in a manner which was not provided for in the initial contract;

(iv) The modification extends the scope of contract considerably;

(v) The variation replaces a contractor in circumstances other than those covered by exception (4).

Condition (iv) above was considered by the Supreme Court in Edenred, which found that a variation will not extend the scope of a contract considerably where the initial contract envisages and provides for the relevant extension. As Lord Hodge explained at [36]:

“I do not accept that one should read the prohibition from modifying a contract to encompass services not initially covered as banning the modification of a public contract which extends the contracted services beyond the level of services provided at the time of the initial contract if the advertised initial contract and related procurement documents envisaged such expansion of services, committed the economic operator to undertake them and required it to have the resources to do so. […] Were it otherwise, it is difficult to see how a government department or other public body could outsource services that were essential to support its own operations and accommodate the occurrence of events and the changes of policy that are part of public life.”

Conditions (ii) and (iii) above were considered at an earlier stage in the proceedings. In respect of (ii), Andrews J considered (with reliance on Pressetext [13]) that the relevant test is whether, had the variations formed part of the initial tender, it would have allowed for the admission of tenderers other than other initially admitted or would have allowed for the acceptance of a tender other than the one initially accepted. Notably this imposes a higher threshold than that applied by Lang J in Gottlieb v Winchester City Council [2015] EWHC 231 (Admin), who found that a claimant “has to satisfy the Court, on the balance of probabilities, that a realistic hypothetical bidder would have applied for the contract, had it been advertised, but he is not required to identify actual potential bidders” (at [69]).

As for (iii), in Edenred Andrews J held (unsurprisingly) that there had been no change to the economic balance of the contract in circumstances where she found on the facts (based on the relevant contractual charging mechanisms) that the contractor would not stand to increase its profit margins as a result of the variation (see [119]-[123]).

Again, therefore, the extent to which contracting authorities may rely on this exception is likely to turn on the terms of the original contract.

Exception (6): Minor variations

Low value changes are permitted as long as the value of the proposed changes is less than:

(i) the relevant threshold in Regulation 5 of the PCR; and

(ii) 10% of the initial contract value for service and supply contracts and 15% of the initial contract value for works contracts

provided that the modification does not alter the overall nature of the contract.

How many variations may be made?

An important final point is that the 50% limit applicable to exceptions (2) and (3) applies each time a variation is made, as long as the change is not with the intention of circumventing the procurement rules. 50% is to be calculated by reference to the original contract (and not 50% of any increased price resulting from an earlier contract).

In contrast, the 10% and 15% limits applicable to exception (6) – minor changes – apply in aggregate (and not each time a change is made). [14]

Concluding thoughts

It is trite that every case turns on its facts, but that could not be more true when it comes to attempts by contractors to be released from existing contractual obligations via force majeure clauses on the basis of COVID-19 and also attempts by contracting authorities to vary public contracts without recourse to a further procurement exercise. While it is undoubtedly the case that COVID-19 provides opportunities in both of these respects, getting off the hook is only likely to be straightforward in exceptional cases.

Parishil Patel QC and Katherine Barnes are barristers at 39 Essex Chambers.

[1] This article follows a 39 Essex Chambers webinar given on 21 July 2020 on “Practical procurement tips in light of the changing landscape brought about by COVID-19” which can be accessed for free here: https://www.39essex.com/practical-procurement-tips-in-light-of-the-changing-landscape-brought-about-by-covid-19/">https://www.39essex.com/practical-procurement-tips-in-light-of-the-changing-landscape-brought-about-by-covid-19/

[2] Classic Maritime Inc v Limbungan Makmur Sdn Bhd and another [2019] EWCA Civ 1102.

[3] Promulgated under the Coronavirus Act 2020.

[4] In March 2020 these Regulations implemented into law the Government’s “lockdown” policy but they have now largely been repealed.

[5] These Regulations require the closure of certain businesses and impose restrictions on gatherings both inside and outside of more than 30 people.

[6] These Regulations make provision for local authorities to give directions restricting public access to premises, events and public outdoor places.

[7] These Regulations impose restrictions on gatherings of two or more people in private dwellings in certain parts of the North of England.

[8] These Regulations require individuals to self-isolate at a chosen location for 14 days following return from certain countries.

[9] See PPN 01/20: Responding to COVID-19; PPN 02/20: Supplier relief due to COVID-19; PPN 03/20 (on use of procurement cards); PPN 04/20: Recovery and transition from COVID-19.

[10] By virtue of Regulation 118 of the PCR, Reg 72 applies equally to contracts awarded under the previous iteration of the PCR (the Public Contracts Regulations 2006). The exception to this are public works concessions.

[11] Directive 2014/24/EU (“the Directive”) (transposed into domestic law by the PCR).

[12] Procurement Policy Note – Responding to COVID-19 (Information Note PPN 01/20) – March 2020.

[13] Pressetext v Republik Österreich (Bund) [2008] EUECJ (C-454/06).

[14] See the guidance from the Crown Commercial Service entitled “Guidance on amendments to contracts during their term” (October 2016).

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